EC103-Topic #4: Fiscal Stimulus Package

Recently, much has been said of an impending recession and what the government or monetary authorities should do to combat a prolonged recession. Ben Bernanke, chairman of the Federal Open Market Committee, recently endorsed a fiscal stimulus package in addition to aggressive monetary actions to fight off a possible recession. However, Dr. Bernanke only advocated certain types of fiscal stimulus in order to improve the timing of the action. Many are concerned that further cuts in overnight lending rates might worsen the economic outlook rather than improve it. However, uncertainty about the usefulness of fiscal policy has also existed since it has been used to stabilize the economy. Fiscal authorities are under pressure from voters to keep the economy from fluctuating, but have had limited success, especially when battling short-run fluctuations. However, many economists still advocate using fiscal policy when facing a long-run shortfall in output.

Questions you might try to answer:

  • Given all that has been discussed in class, do you agree with or disagree with the steps taken by the monetary and fiscal authorities since the beginning of 2008?
  • Knowing that the current economic downturn/slowdown is related to credit markets, what other tools has the Fed used to try and create more liquidity in the economy? Will using these tools have an impact on output in the short-run? long-run?
  • If it turns out that the economy has a quick recovery, and shows signs of growth by the end of the year, what should a ‘responsible’ fiscal authority do in order to counteract the moves made during the first half of 2008? Do you think this is politically possible?

I would like your statements to be as subjective as possible, or in jargon terms, positive and not normative in nature. Also, remember, I want you to keep your descriptions short, basic, and related to classroom content. Read other students comments before posting, and please leave your name with your posting.

15 thoughts on “EC103-Topic #4: Fiscal Stimulus Package”

  1. In the short run, based on the fact that 70% of American demand for goods relies on consumer, the $117b in tax rebate will hopefully urge people to spend. However, the value of houses have fallen and with it fell homeowners biggest asset and thus their confidence. This insecurity tends to dwell on in the long-term rather than the short, making any fiscal stimulus less effective,(as people save rather than spend) and the monetary policy more pungent,(as spending slows down so does inflation). The Fed might therefore only be able to keep a watchful eye on the economy and make sure the politician’s aim of long-term tax-cuts do not harm the economy through future inflation. America has not experienced a “scary” recession in decades and might fear it more than necessary. Exports are rising due to the low dollar and the inflation rate is expected to fall. This cooling process might be good, through fine-tuning the role of debt, by making it less fundamental for economic growth. In my opinion, the most important aim for the Feds must be to build up and sustain the confidence in the dollar. This then is done through Bernanke’s goals of keeping the inflation low and slowly but surely, regaining economic momentum. Reference: The New York times, “Fed Chief Backs Quick Action to Aid Economy” Economist “The great American slowdown”written by K.C. Tidemand

  2. I agree with Bernanke’s stance on taking quick action now to help the economy. The “What’s a Fiscal Authority to do?” article puts it best when stating the fact that by the time all the politics are through and a economic stimulus bill is passed it may be too late. Either the economy can worsen in the time, or it gets better and the new bill will be of no help. In fact, the Martin Feldstein article said that a bill that comes too late could make a downturn worse, or an upswing to higher inflation. By taking action when it is most necessary instead of dealing with political hold ups and ramifications something positive can be done. However, there is also a downside to taking quick action. If action is taken too quickly the true nature of the situation may not have been fully comprehended. This action could make the situation worse and make our policy makers seem incompetent. People could then lose faith in our economic experts, which can lead to a host of other problems.Perhaps the best response is to take quick action as Bernanke has stated is the best option, but to also not make it anything too drastic. Bernanke has said that our economy is “extremely resilient,” so any major changes to help our economy could be harmful down the road. I picture the economy as a sailboat out on the water; the wind has begun to ease up and the boat may have slowed a bit, but drastic steering towards hopefully windier waters is not the best option. Over-steering can cause the boat to stall and not make it back to those windier waters for quite some time.-Kevin Sergo

  3. As we have discussed in class on many occasions, there is a looming possibility of an economic recession. This recession is claimed to be the direct result of a slump in the housing market, as well as the financial markets and the rising costs of oil and fuel prices. Monetary and fiscal authorities have implemented many policies to curb this recession, including cutting interest rates and a fiscal stimulus package. First, monetary policy is concerned with changes in the money supply and interest rate, which is controlled by the central bank or the Federal Reserve (Fed) in the United States. As the “What’s a Fiscal Authority to Do,” article states, lowering interest rates reduces the cost of borrowing, which accommodates investment and “consumption spending.” I agree that lowering interest rates is a plausible method to induce spending in the short run but how much should the Fed cut interest rates is the question. As the “Enough with the Interest Rate Cuts” article states, lowering interest rates may raise the already high prices of energy and food and may drive up the prices of commodities. Looking at the financial and housing markets, one of the major causes of the impending recession, lowering interest rates will have little impact on these markets as it is hard for people to obtain credit. Second, fiscal authorities have proposed a fiscal stimulus package that would promote economic growth, including tax cuts, tax rebates, and extended unemployment compensation. I do not believe that this package should be implemented and if it is I believe it should be temporary. A package could promote growth but in the long run, not immediately. Passing legislation such as this package that is concerned with future spending is always tricky as we are not sure what will be the state of the economy. Proposed with this package is a tax cut but cutting taxes while increasing government spending leads to greater budget deficits. Perhaps we should ride this recession out rather than trying to curb it. As we learned in class, a recession will “clean” the economy and lead to future expansion. L. Curtis

  4. If the stimulus package that so many politicians and financial leaders, including Ben Bernake are touting is a success, the nation would still not be out of the fire. As Dr. Bernake said in his testimony in front of the House budgetary committee, any stimulus package should be “explicitly temporary,” aimed at getting people to spend more in the next year or so without creating a heavy new load of national debt. Bernake also warned that Congress should stay away from any fiscal changes that would change the long term growth of the economy such as tax reductions or a huge increase in government spending in order to increase output levels (New York Times). Aside from any action from Washington, the Fed itself needs to be wary about what measures it takes, Martin Feldstein, in an article for the Wall Street Journal, warns that any further rate cut by the feds could do more harm than good, with interest rates already low and a huge inventory of houses, lowering the rates anymore will not stimulate people to suddenly buy a house. Lower interest rates certainly will not encourage people to save money, but as the cost of consuming rising so quickly, people can not to afford to consume much anyway. Hopefully the rate cuts that have already been put in place will serve as a band aid for the financial institutes that have been hit so hard by the credit crunch, but as the economy recovers interest rates will need to be raised again to combat the rise in prices. The big issue is how Americans will respond when the politicians who are telling them about how they are going to make jobs and cut taxes and fight inflation, start telling people that they need to raise taxes again to pay off the National Debt, and that interest rates are going to keep riding a roller coaster. Just as political pressures made The President cut taxes originally, political pressures may cause Congress to go overboard with their stimulus package and start spending cash to over expand a healing economy down the road. Now is the time for the nation’s leaders and economists to do a delicate balancing act between needed stimulus to inoculate the ailing growth, and extravagant spending and tax cuts that might send the economy careening out of control. What Congress should do to keep themselves from overheating the economy is have automatic reductions scaling back any tax cuts or spending that will reduce themselves as the economy recovers, regardless of who is in control of the Hill at that time.Hal BermanWorks Consulted:The New York times, “Fed Chief Backs Quick Action to Aid Economy” Economist “The great American slowdown”econblog.aplia.com/2008/01/whats-fiscal-authority-to-do.html

  5. The steps the Fed has taken to combat the economic slowdown were well executed and thought out. The Fed acted quickly, a necessity in preventing a recession, and its actions in lowering the interest rate were essential in putting more money into the hands of both consumers and banks. The only drawback I see to the Fed’s actions lies in Martin Feldstein’s argument that there is only so much you can cut interest rates to encourage consumption and investment. After a certain point, lowering the interest rate will do little to help the economic slowdown, and with the drastic cuts the Fed has already implemented it seems this point is approaching. If the interest rate cuts have not yielded the necessary boost for the economy, then it is time that the Fed becomes creative and uses another means to target consumption and investment.Changes in fiscal policy were quick to be implemented as well; hearing of an economic downturn Congress was prompt in ratifying a stimulus package. However, that was in January. It is now April and the checks still are not in the mail. While the stimulus would be very helpful to the economy if implemented when needed, it is unclear whether it will have come in time to have its intended, or perhaps an even worse effect on the economy. A danger of Congress’s recent tax cuts lies in whether they will be temporary or not. If the economy has a quick recovery and shows signs of growth, taxes should be returned to their state before the recent cuts in order to counteract the fiscal policy promoting consumer spending and the overall size of the money supply. This counter-inflationary response would curb the growth of the money supply. However, politically speaking it will be difficult to accomplish such a fiscal change due to politicians’ differing ideological standpoints and individual priorities. With this in mind as well as the questionable affects of the tax cuts, I am unsure of whether the stimulus package should have been passed at all. If in the future a way is developed to apply a stimulus package almost immediately after it is ratified, then I think that such fiscal reactions to the threat of recessions is a great thing. Until that point though, stimulus packages should be considered only when absolutely necessary.-Evelyn Fanneron

  6. The United States economy is facing some serious trouble, the problem we face; extremely low growth, a weak dollar, increasing commodity costs, and spiking inflation rates. We have seen this formula before in the 1970’s, but fed chairman Dr. Bernanke thinks we are set on a different path. With his recent advocacy for an interest rate cut stimuli, he thinks we can turn the short term around. Some questions we face as a nation could be is this even the right stimulus move for us? Some democrats favor an increase in cash to boost the economy in forms of tax rebate for middle to low class families by extending jobless benefits, and making food stamps more available (Naylor 1). I think that we should let our economy cool down and feel the effects of the last tax cut and rate cut before we go ahead and take more action. Agreeing with K.C. Tidemans post, the economy by nature tends to balance itself over the long run, and with growing exports, our economy could in fact do this. It’s important that we don’t go chop every rate, because we may actually cut the feet from under us in the long run.Mike Jennings”Bernanke Pushes Economic Stimulus Plan”http://www.npr.org/templates/story/story.php?storyId=18184520

  7. In light of recent fears that our economy is going into a deep recession, the actions that the Fed are taking are both appropriate and necessary to stimulate the economy. Recent tax cuts leave consumers more willing to spend the money they have saved, thus stimulating cash flow in the economy. It may seem that the Fed fails to take action in time to help a recession, since we often don’t know we are in a recession until it is over. Bernanke and many other economic experts agree that acting fast in the face of economic slow-down is the smartest option, but that is important to avoid taking actions that are too drastic. Fear among consumers leads to a decrease in spending. Banks may want to hold on to their money, making it increasingly difficult among banks AND consumers to lend and borrow. Drastic changes may harm the economy in both

  8. High oil prices, the declining value of the dollar, rising unemployment, these all appear to the symptoms of a recession. Federal Reserve chairman, Ben S. Bernanke announced that he would instill a temporary fiscal stimulus package to ease the malaise of the economy. The goal of the Fiscal Stimulus is literally just to stimulate the economy, not to drive it. Cutting interest rates are designed to encourage consumers to spend and invest, and help promote more activity in the market. However, the “monetary medicine” that Bernanke has “prescribed” have “yet to produce a turnaround.” Fearing that too much intervention would only exacerbate the problem, Bernanke hopes to rely on the “automatic stabilizing effects that are built into the tax and unemployment benefit rules of [the] fiscal system”. With a slow growth economy hints of an impending recession have the Federal Reserve in a tizzy over the uncertainty about the effects of fiscal policy. Bernanke’s policies are facing criticism according to the New York Times article, “The Education of Ben Bernanke”. Much criticism is due towards Bernanke’s failure to foresee that the sudden rise in homeowner defaults in the sub-prime housing market, which triggered the crisis, would have far-reaching effects. Ultimately, I agree with Bernanke’s logic for providing a temporary relief to the ailing economy in order to prevent any further damage to the already suffering U.S. economy.-Bejan

  9. “The chairman said any stimulus package should be “explicitly temporary,” aimed at getting people to spend more in the next year or so without creating a heavy new load of national debt.”This statement pretty much sums up the reasons i support this package. Creating some sort of long term package at this point seems unnecessary as the country has not yet dipped into any sort of recession. As the Bernanke explains in the article, the economy is still growing, just at a decreasing pace. This, of course, is a concern because it could be foreshadowing a prolonged recession for the future. However, the government can not predict such economic patterns. So, if the government is unable to predict long term economic growth or decline, it seems unreasonable for a long term plan to be initiated. This “explicitly temporary” plan seems reasonable to combat this gradual decrease in economic growth because tax cuts are a sure-fire way to get people spending more money. And, as people spend more money, the inflation rate will invariably drop. Given that this fiscal stimulus package is a success, the fiscal authorities will once again have to come up with an idea of how to counteract the decrease in taxes for the first half of 2008. Personally, i think it is difficult to decide how the fiscal authority should act responsibly after the conclusion of this package. Factors such as the housing market, gas prices, and various credit markets will affect how the government must act. As of now, gas prices are incredibly high, but this pattern of price gouging could decrease or even reverse in the future. Given that these factors are, for the most part, unpredictable, so too will the actions of the fed in response to them.-James O’Connellworks consulted:The New York times, “Fed Chief Backs Quick Action to Aid Economy”

  10. The possibility of a recession of the U.S. economy in 2008 has become one of the most debated issues. The government as well as the Federal Reserve has been working on this issue in order to stimulate the U.S. economy. As for the Government, it uses fiscal policy, such as tax cuts, in order to persuade consumers to increase their spending; this would contribute to expedite the economic growth. This policy would work effectively (in the long-run after going through a long legislative process) because consumers would feel wealthier and this subsequent feeling of wealth will help increase spending. As a result, this increase will cause output to rise. However, there are some disadvantages with such a policy. The first drawback of the government’s fiscal policy is that the economy grows at the expense of the government’s budget; the tax cut policy can increase the federal government’s budget deficit meaning that the government’s expenses exceed its incomes. Another drawback of the fiscal action is that there is a time lag between changes in the economy and the implementation of fiscal policy. In other words, a fiscal policy’s “impact [may occur] later than intended, exaggerating the [economic] cycle and turning a downturn into a slump or an upturn into inflation.” As stated earlier, the last drawback of the fiscal policy is that it is not always flexible enough; for example, the tax cuts must go through a lengthy legislative process. The Federal Reserve has helped to stabilize the U.S. economy as well. It cut interest-rates in order to stimulate the economy. One benefit of using this monetary policy is that it is a quick and flexible action that could quickly affect consumers’ incentive to become active in the economy. As interest rates decrease, consumers will hold more money because the opportunity cost of holding money decreases. Another advantage of the interest-rate cuts is that it would be relatively cheaper for investors to borrow money in order to fund their new projects. As a result, this policy will stimulate consumption and investment spending creating more output in the economy. Nevertheless, the monetary policy has a drawback as well. The interest-rate cuts’ action could be a warning to consumers that there might be something wrong with the economy. As a result, they might decrease their spending in an attempt to protect themselves from the possibilities of further decreasing economic growth or possibly even a recession. Instead of helping the economy, this could worsen the economy and worsen the recession. Because of the reasons mentioned earlier, I do agree with monetary action, but not fiscal policy. Even though the housing market is collapsing, the “U.S. exports will likely continue to grow at a healthy pace in coming quarters, providing some impetus to the domestic economy.” Consequently, I believe, this potential recession will be just a short-term slump; the fiscal policy may be counterproductive or even cause inflation.As implied earlier, if it turns out that the economy recovers quickly, and shows signs of growth by the end of the year, the fiscal tax cuts may generate inflation. One option the government has is to work with the Federal Reserve Bank to slowly increase interest rates and to gradually remove the fiscal tax cut policy. As for the current economic downturn that is related to the credit markets, the Fed could aim to decrease the federal funds rate by conducting open-market purchases; this will increase reserves so that banks would have more money to lend out with lower interest rate.-Korlarp Suwacharangkul

  11. The slowdown in the US economy due to quickly increasing oil prices and problems in the housing and financial markets should be fixed through a suggested short-term stimulus package. Mr. Bernanke emphasizes that this plan be short term. Bush is working to make his “short term” tax cuts, a few years ago, permanent. The short-term plan has been estimated to cost between $100 and $150 billion. Economic stimulus such as increased tax rebates, job programs, and extended unemployment compensation could be included in this package. Increased tax rebate would create incentive to spend and increase the flow of money through the economy. Some republicans, including Bush, want to make tax cuts germinant, but this could potentially hurt in the long run. This would decrease government spending and increase inflation. Exports are increasing steadily because the value of the dollar is falling and the economies of our major trade partners are booming. This will help boost the economy somewhat. Finally keeping inflation low along with the strictly short-term stimulus package should help the economy and should aim to increase confidence in the US dollar.The New York times, “Fed Chief Backs Quick Action to Aid Economy” Josh Gladstone

  12. In the early months of 2008, the Federal Reserve has taken many steps to combat the ailing economy. However, a Band-Aid cannot heal a broken bone. The proposed $117b stimulus package may fortify consumers and perhaps enhance economic activity, but it will not cure Wall Street and its credit woes. Our financial structure relies on liquidity and the availability of capital. In the face of the credit crunch, the Fed has lowered interest rates in order to pump more liquidity into the economy. While the Fed maintains that these rate cuts are necessary, even critical, to unblock the credit freeze and get the economy moving again, it is inarguable that repeated rate cuts, especially those that bring rates well below historical norms, contribute to inflation. Thus the Fed is caught between the proverbial rock and a hard place, with no good solution, perhaps just a less bad one. Another dilemma for the Fed is whether to extend a lifeline to failing non-bank financial institutions, such as it did in underwriting much of the financial risk in the merger it arranged between a nearly-defunct Bear Stearns and JP Morgan Chase. While the Fed argues that this action was necessary to protect the entire financial system from possible collapse, it can be argued that the Fed, in an unprecedented move, is using taxpayer dollars to indirectly encourage risky behavior thus creating a “moral hazard.” In my view, the best way to increase liquidity is pro-growth tax reduction, and this has been borne out many times in the past. If people keep more of their money and can choose to either save or spend it, rather than give it to the government, both personal savings and economic activity are often enhanced. History has shown both in the short-run and long-run, pro-growth tax reduction actually increases government revenues. This was clearly demonstrated by significant capital gains tax reductions by Presidents Kennedy and Reagan. Once the Fed rate cuts, perhaps combined with tax cuts, get some traction, the last half of 2008 could turn out to be better than present predictions. At that point, the Fed will turn its attention towards inflationary pressures and begin to raise interest rates. In addition, policy makers will have to finally take actions to reverse the implosion of the U.S. dollar versus other foreign currencies. A weak dollar undermines the economy by discouraging foreign investment in U.S. dollar-denominated securities and pushes up the price of commodities like oil. Pro-growth tax reduction is what this economy needs, something that neither Democratic candidate is even considering, even though it has worked in the past for both sides of the political divide. -D. Cohen

  13. The economy is in a very precarious position, and the tools that the government has to combat a possible recession are dangerous in that they exacerbate the already growing problem by adding a level of validity to the fear felt by consumers and investors alike. For politicians, a recession is a black mark on their records, and they like to say they have introduced programs to help, with attractive names like stimulus package or growth package to assure taxpayers that someone is looking out for them. What’s difficult to realize is that the recession is partially a product of expectation, that is to say, of low expectations for the American economy. People have been losing faith in the market and are clamoring for the government to do something to fix it, and Bush was happy to make a stop on Wall Street to assure the brokers that everything will be solved by government intervention, sort of like an economic deus ex machina. It’s rather naïve to think that a few hundred dollars worth of stimulation is what the economy needs. There has not always been a favorable result from so much government intervention into free market problems, and having Bernanke throw money at everyone saying, “spend it and help us out” is not going to fix an economy the way that people think it will. It’s not a simply spend and get a result kind of affair. We won’t know if the rampant spending we’ve undertaken is going to have any positive effect, or if it isn’t simply going to exacerbate the problem.- Aaron M.

  14. As explained by Stephen Cecchetti in his article “Federal Reserve policy responses to the crisis of 2007-2008: A summary,” the Fed has done a lot to adjust their policies in light of an economic problem which had not been encountered before. The role of a central bank in the time of an economic crisis is to provide liquidity to firms that need it, yet firms that needed it were not getting the liquidity that they needed. The problem was the declining quality of new mortgages and the fact that mortgages were becoming less secure because they had spread beyond the reach of government-backed institutions that normally provide this security. In response to this crisis, the Fed provided reserves to combat the problems with interbank lending. However, as the crisis became worse, these tools that the Fed was using, such as reductions in the target federal funds rate did not have much impact on this interbank lending market (Cecchetti, 2008) In response to these failing policies, the Fed created the Term Securities Lending Facility (TSLF) which “offers commercial banks funds through an anonymous auction facility that seeks to eliminate the stigma attached to normal discount borrowing,” (Cecchetti, 2008). This allows banks to borrow Treasury bills, notes and bonds using the mortgage-backed securities as collateral. The Fed also changed some of their current policies such as extending the term of temporary repurchase agreements, making agreements with European and Swiss central banks to offer dollars to their commercial banks, and loaned money to Bear Stearns to keep operating, but be taken over by JP Morgan Chase (Cecchetti, 2008). The Fed has been flexible in light of the fact that previous policies were no longer having the effect that was needed. This is important because that means that the Fed is willing to do what it must to improve the economy. Source: Cecchetti, S. (2008, April 10). Federal Reserve policy responses to the crisis of 2007-08: A summary. Message posted to http://www.voxeu.org/index.php?q=node/1048-written by Sarah Keeney

  15. In terms of monetary policy, Dr. Bernanke is taking logical steps towards curbing the impending recession. Traditionally, cutting the federal funds rate has encouraged people to participate more actively in the lending market and boost the economy. Unfortunately, the situation that now faces the country in regards to the housing crisis and current credit crunch has taken a toll on lenders’ confidence and indeed in the borrower’s ability and desire to borrow. Though in the past lowering the federal funds rate has proven to boost the lending and borrowing market, this action seems to be a quick fix for a problem that will take time to remedy. The over-arching mentality that is imposed on consumers by the media and by lenders, is that this is not the time to borrow. With the financial troubles that have recently plagued several major investment firms (Merrill Lynch, Bear Stearns, etc) it is not surprising that people are wary of investment and just as easy to see why firms are nervous about lending. Unfortunately, the current unease will take a more than lowering the interest rates. The fiscal action that the government has taken, while well-intentioned, will not have the immediate effects that they seek. It takes a months, sometimes years to reap the benefits of tax cuts. In the four months that have elapsed since the cuts were passed, no one has benefited. The expectance of these cuts may help to soften the unease and uncertainty from which consumers suffer, and to allay the concerns of firms in the ability of creditors to repay their debts, but in practical terms, the results of these cuts will be seen over a longer period of time. If the a sudden (and unexpected) upturn in economy were to take place, then a responsible government would repeal the tax cuts passed last January. The superfluous money would become harmful to an economy that was producing at potential and only increase inflation at an undue velocity. Unfortunately, once tax cuts are in place, it is exceedingly difficult to remove them. Congressmen like to stay in office, and the removal of a policy benefiting their constituents is not likely to gain them reelection—no one votes for the senator who took away their tax cut. Thus the difficulty in using fiscal policy to regulate blips in the economic trajectory. In the long run, the efforts of the fed and of congress should help the economy; they are following historical precedent in a situation that has no historically identical counterpart. Whether they have reached the bottom of the barrel in terms of correctionary means remains to be seen. In my opinion, the monetary policy enacted thus far has been just, however, I doubt that a continuance in this direction will do any good. The fiscal policy was well-intentioned, but is not as immediately practical as congress had foreseen. Meg Ashur

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